Most readers would already be aware that EDP Renováveis' (ELI:EDPR) stock increased significantly by 16% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to EDP Renováveis' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Do You Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for EDP Renováveis is:
5.5% = €558m ÷ €10b (Based on the trailing twelve months to June 2021).
The 'return' refers to a company's earnings over the last year. That means that for every €1 worth of shareholders' equity, the company generated €0.06 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of EDP Renováveis' Earnings Growth And 5.5% ROE
On the face of it, EDP Renováveis' ROE is not much to talk about. Next, when compared to the average industry ROE of 7.9%, the company's ROE leaves us feeling even less enthusiastic. In spite of this, EDP Renováveis was able to grow its net income considerably, at a rate of 30% in the last five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared EDP Renováveis' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about EDP Renováveis''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is EDP Renováveis Making Efficient Use Of Its Profits?
EDP Renováveis has a really low three-year median payout ratio of 18%, meaning that it has the remaining 82% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Additionally, EDP Renováveis has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 16%. Still, forecasts suggest that EDP Renováveis' future ROE will rise to 7.0% even though the the company's payout ratio is not expected to change by much.
In total, it does look like EDP Renováveis has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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